WASHINGTON–Republicans unhappy with the Federal Reserve are
circulating an idea that long ago lost currency with most
economists: a gold standard.

In an election season shaken by terrorism fears, immigration
politics and economic anxiety, a shiny precious metal might seem
like an odd fixation, but Senator Ted Cruz of Texas, a Republican
presidential hopeful, said recently that the dollar should have a
fixed value in gold, and some rivals for the Republican nomination
said a return to the old standard was worth studying.

The rhetoric is rooted in concern that the Fed’s efforts to revive
economic growth have loosened its hold on inflation. A gold
standard, proponents argue, would limit the Fed’s ability to create
money, thus ensuring prices remain stable.

But economic historians describe this as nostalgia for a time that
never was. Proponents of the gold standard generally overstate the
benefits of putting golden handcuffs on a central bank, historians
say, and the costs of that reduced flexibility are considerable.

In 2012, the University of Chicago asked 40 leading economists
whether a gold standard would improve the lives of average
Americans. All 40 said no.

“You can do a lot better than a gold standard,” said Michael Bordo,
an economist and director of the Center for Monetary and Financial
History at Rutgers University. He described the political interest
in the precious metal as “pretty crazy.”

The gold standard was invented to constrain government spending.
Nations that agreed to exchange money for gold thought twice before
printing more money. And lately, Republicans have found themselves
yearning for such restraint.

After the 2008 recession, the Fed began a campaign to stimulate
economic growth. It has held short-term interest rates near zero
since December 2008, and it put further pressure on long-term rates
by creating trillions of dollars to buy Treasuries and mortgage
bonds. Both measures aimed to spur risk-taking by investors and
borrowing by businesses and consumers.

Republicans have warned since the outset that the Fed was losing
control of inflation. During the 2012 campaign, Rick Perry, then the
governor of Texas and a Republican presidential candidate, called
the Fed’s policies “treasonous” and warned that if Ben S. Bernanke,
then the Fed chairman, came to Texas, “we would treat him pretty
ugly.” The party added a plank to its platform calling for a
commission “to investigate possible ways to set a fixed value for
the dollar,” reviving language last seen in 1984.

Instead, four years later, inflation remains unusually sluggish.
Some economists and Fed officials argue the economy would benefit
from a little more. But the language of the Fed’s critics remains
heated.

“Instead of adjusting monetary policy according to whims and getting
it wrong over and over again and causing booms and busts, what the
Fed should be doing is, No. 1, keeping our money tied to a stable
level of gold,” Mr. Cruz said last month during a Republican
presidential debate.

Senator Rand Paul, Republican of Kentucky, agreed that the Fed
“destroys the value of the currency” by allowing too much inflation.
Ben Carson and Mike Huckabee, former Arkansas governor, both agreed
that the value of the dollar should be tied to something.

“If it’s not going to be gold, make it the commodity basket,” Mr.
Huckabee said.

Economists generally regard a gold standard as a crude and outdated
method of inflation control. There is nothing inherently stable
about the value of gold. It fluctuates, like the value of everything
else, as more is extracted from the ground and as demand waxes and
wanes.

The bigger problem, however, is that economic conditions are
unstable. And during recessions, printing money can help revive
economic activity. Nations began to rebound from the Great
Depression when they began to abandon gold. Most developed nations
now ask central banks to strike a balance between stabilizing broad
measures of price inflation and encouraging economic growth, and
then leave it to the technocrats to decide how much money to print.

“The real world is a complex place,” Adam Posen, president of the
Peterson Institute for International Economics, wrote in a recent
defense of the need for human judgment in making monetary policy.
“Driverless cars would veer from side to side and cause crashes if
their guidance algorithm was limited to just maintaining the
distance from the car in front of them, instead of assimilating more
information as they went. The U.S. economy cannot be safely run on
autopilot either.”

Barry Eichengreen, an economic historian at the University of
California, Berkeley, said life under the gold standard, during its
heyday around the turn of the last century, more closely resembled
modern central banking than is commonly recognized. The Bank of
England held extra gold so it could print extra money if necessary,
for example, and nations frequently suspended their standards during
periods of extreme duress.

But Mr. Eichengreen emphasized that these leniencies proved
insufficient, and that policy makers had made “steady and
significant progress” in the intervening decades toward improving
the management of monetary policy.

“There is a long history in the United States, going back to Andrew
Jackson, of deep skepticism of the power of anonymous financial
technocrats,” Mr. Eichengreen said. “This wish to substitute simple
rules partly reflects a strain of political ideology that thinks
government intervention only causes problems and never solves them.
And partly it reflects a lack of careful understanding of how these
earlier regimes work.”

In fact, the gold standard did not even work during periods of calm.
What is often described as an era of stable prices was more like a
roller-coaster ride that ended back where it began, after bursts of
inflation and deflation.

Mr. Bordo has calculated that economic volatility in the United
States was significantly greater during the gold standard years, and
the nation’s unemployment rate, on average, was almost a full
percentage point higher.

“When people look back and say the gold standard was wonderful, they
forget about the short-run swings,” he said.

Even economists who want to remove human judgment from monetary
policy tend to look down on the gold standard. Milton Friedman, a
conservative economic icon, suggested that monetary policy should
not be determined by people or by gold, but instead by a computer
program.

The last few years have served as a reminder that steering straight
ahead is not necessarily the best policy during a storm. After the
financial crisis, the Fed has embraced responsibility not just for
inflation but also for economic and financial stability, and other
central banks have followed its path.

And congressional Republicans, while levying many of the same
criticisms against the Fed as the party’s presidential candidates,
have proved unwilling to impose a rigid rule.

The House of Representatives last month passed legislation requiring
the Fed to choose its own rule for setting interest-rate levels–a
Fed standard–and explain any deviations. The legislation includes
a suggested rule, known as the Taylor Rule, which tries to formalize
a balance between economic growth and inflation, effectively
allowing some amount of extra money printing during recessions.

A similar Senate bill would not require the Fed to pick a rule, but
instead to compare its conduct of monetary policy with several
reference rules in regular reports to Congress.

“We will not fully realize robust economic growth until the Fed
changes the conduct of its monetary policy,” Representative Bill
Huizenga, the Michigan Republican who wrote the House bill, said
during the final debate on the House floor. He then emphasized that
the legislation would leave the Fed free to “develop what it
believes is the best course of action on monetary policy.”

—
A friend alerted me to this article and I replied:

Thanks for this. Reading it makes me call myself a militant agnostic on
the whole business of macroeconomics. Both teachers in the two
macroeconomics courses I had to suffer in graduate school were terrible
and bad, resp. My math background (I took most of UVa’s graduate math
courses as an undergraduate and got sick of the subject at the more arid,
abstract level. I got an NSF Graduate Fellowship and was able to switch
from math to economics, at Jim Buchanan’s convincing the graduate school
director to let me do so, even without studying economics at all.) My
mathematical mind insists on logical coherence. What I got was a whole
bunch of equations that seemingly came out of nowhere.

I have forgotten nearly everything I was supposed to have learned, but I
do remember the Keynesian multiplier. Add a dollar to the economy. If the
marginal propensity to consume turns out to be 80%, 80¢ will flow back
into the economy and lead firms to expand their businesses. The marginal
propensity to consume *presumably* not having changed, 80% of 80¢ = 64¢
will be added. Keep going, 80% of 64¢ = 51.2¢. Keep going: 40.96¢.

Add them 80+64+51.2+40.96 = $2.3616. In the limit, you get $1/1-.80)= $5
of economic growth. *Magic*! But wait, the 80% figure is not some grand
truth about modern men, ancient men, chimps, …. single-celled animals.
It is, it is claimed, an empirical fact about this economy now, as we get
a good correlation.

Here’s where the error comes in: the empirical data is based on the
aggregate. It’s just a generalization. There is no force of nature
behind it. It does not mean that adding $1 will mean increasing GDP by $5.

The scholars have many different formulae, all backed up, so each one says, by broad data. This leads to conflict, and must of the economic literature consists of arguing that one’s own statistical methods are better than the others. The great Carl Friedrich Gauss showed that least square estimators are unbiased provided independence of the independent variables and lots of other things hold, which they rarely do. You can do better than Gauss by various manipulations, but the fanciest manipulations are rarely better than a simple manipulation, like feeding back the residuals into the mesh of equations. (This is two-stage least squares, which I may have reinvented when I worked at the Civil Aeronautics Board, back in the bad old days where the research staff (including me) were at the mercy of the Keepers of the Holy IBM 360 mainframe. We could slip in our punched cards and maybe get the printout the next morning. An error in one card meant another day waiting. The upshot is that I had plenty of time to ponder the printouts. Today, I’d do it all on my desktop and run hundreds of trials and never get my hands dirty.)

What is my macroeconomic philosophy? Don’t *really* one, just an abiding
distrust of government, generously expanded by having lived among the
bureaucrats far longer than Margaret Mead lived among the Samoans.

Gold standard? I agree with Applebaum here that the price of gold
fluctuates too much. The Austrian economist, Murray Rothbard, pulled a
fast one in _America’s Great Depression_ when he argued that the discovery
of piles of gold in the New World somehow did not mean inflation!

For a while in the Summer before I entered graduate economics, I got paid
to do research for Gordon Tullock. He asked me to do some research and
find out whether there were any *economic* objections to inflation per se,
not against runaway inflation, but only the sort of inflation that was
predictable. The best I could come up with was a Christian arguing that he
could find no justification in the Bible and could not himself imagine
Jesus spouting inflation! Nowadays I might say that the problem with
inflation is that its effects are often so remote as to be unpredictable,
so much so that hardheaded businessmen could not make appropriate
adjustments, even if the Free Market suggests that they can.

Well, what about a commodity basket made of many things, including or not
including gold? My suspicion is that what the basket consists of will be
the subject of haggling and rent-seeking.

In the end, what about no regulations on banking, letting anyone set up
his own currency, often called wildcat banking? The problem is one of
trust. Bitcoin can’t work, since it is mysterious and wide open to fraud.
Healthy though my distrust of (government) authority may be, it is not
infinite.

I have no answers.

Much best,
Frank

—
Frank,

I am just old enough to remember those punched cards that used to go into
computers. When I was relatively new at the World Bank, I was sent out to
Nigeria inter alia to try to find out why we were not getting any results
back from a Census of Cocoa Farmers which we had helped to finance. The
answer turned out to be that the local rats had gotten into the room where
the punched cards were being stored, and had eaten a good deal of the
data!

I can understand the theoretical objection that many conservatives have
with discretionary monetary policy. If one gives discretion to officials,
one worries that they will misuse it somehow, whether to speed up a
recovery which might otherwise have been left to the market to sort out
eventually, or to fire up inflation or whatever. Pragmatically, though, I
have the feeling that in monetary policy (if by no means always in
regulation), the Fed has in recent times actually been doing quite well.
Meltzer and others have for years now been warning of an inflation that
has just not showed up.

Free banking, I’m afraid, reminds me too much of the classic movie
Stagecoach, where the sanctimonious banker in the stagecoach eventually
turns out to be in the process of absconding with his depositors’ funds!
_______________________________________________
tt